It’s way too soon to determine whether OPEC’s 13 members are complying with the production cut that they were supposed to have started enacting on January 1. But the coming weeks could provide more clarity on this issue, even as other developments in the global oil supply/demand balance weigh on the minds of market participants and observers. This was the conclusion of the International Energy Agency (IEA) in its most recent monthly report, the major takeaways of which we will now address.
The IEA once again upwardly revised its estimate for world oil demand growth in 2016 to 1.5 M/bpd, with most of the revision contributed by stronger European demand, mainly in LPG and diesel. Europe has seen two years of year-on-year growth following nine straight years of flat or declining demand.
But this year, the IEA still expects the rate of growth for global demand to decline to 1.3 M/bpd, albeit this is slightly above the average rate of 1.2 M/bpd seen this century. The prospect of higher product prices – assuming that the cost of crude oil rises in 2017 – plus the possibility of a stronger US dollar are factors behind its reduced demand growth outlook for 2017.
Turning to non-OPEC countries, the stabilization of Brent prices around $55/bbl since mid-December, and the assumption that lower production from the parties to the output agreement will probably see prices rise, is encouraging higher cost producers, particularly US shale producers.
Baker Hughes weekly data show the rig count increasing six consecutive months to November after bottoming out in May 2016. In fact, preliminary data for December indicate the highest number of new rigs added since April 2014, months before oil prices started collapsing. Furthermore, the IEA update cited recent reports revealing that the productivity of shale activity has also drastically improved. “Whether it be shorter drilling times or larger amounts of oil produced per well, there is no doubt that the US shale industry has emerged from the $30/bbl oil world we lived in a year ago much leaner and fitter,” the IEA said.
The agency has expected for quite some time that light, tight oil production (LTO) will increase this year, but it now expects an even larger increase of 170,000 bpd, following a decline of almost 300,000 bpd in 2016. The IEA’s Executive Director Fatih Birol said in Davos, Switzerland, last week that he projected US shale production to rise by as much as 500,000 bpd over the course of this year, which would set a new record.
Other non-OPEC producers are revving up this year, with long-planned projects coming online in Canada and Brazil, whose combined output is seen rising by 415,000 bpd. In China and Colombia, the IEA said the steep production declines last year will be reduced. And for non-OPEC as a whole, net production growth will be 380,000 bpd, after factoring in the major non-OPEC production cut agreement that followed the OPEC deal. And that increase could be supplemented by higher output from Nigeria and Libya, both of which are exempt from the OPEC deal.
Returning to these two output cut deals, as we’ve noted repeatedly, their medium and longer-term impact will fundamentally depend on whether the parties to the deal comply with its precepts. Concerning the OPEC agreement- which calls for production to be limited to 32.5 M/bpd (-1.5 M/bpd from current levels), Saudi Arabia Energy Minister Khalid al-Falih recently said that it may not be extended beyond the first half of the year. Here’s what the IEA said regarding those comments: “By saying that an extension was ‘unlikely’ he has issued a powerful reminder that if stocks are drawn in the first half of 2017 by the approximately 0.7 Mb/d implied by OPEC producing close to its target with support from other producers, the market will have tightened and prices stabilized but not at a sufficiently high level to allow another bonanza for high-cost producers.”
In the meantime, the global oil market awaits the outcome of the output deal. If we use only history as a precedent, compliance looks doubtful. This is because OPEC has no binding mechanism to enforce an output cap. This was forcefully evidenced by the group’s December 2015 meeting, in which the then-30 M/bpd quota was abandoned entirely in recognition of then-existing production of 31.5 M/bpd. Since then, OPEC’s production has risen, with Saudi above 10 M/bpd every month last year save November, Iran approaching its post-sanctions output goal of 4 M/bpd, Libya and Nigeria ramping back up as civil strife somewhat abates, and Angola unseating Nigeria as Africa’s top oil producer. Now, the production cut deal sees output reduced to 32.5 M/bpd, thus still well above actual 2016 production.
The non-OPEC deal calls for a production cut of 580,000 bpd by Russia and other major producers. Again, whether the cuts will be efficacious depends on compliance. The absence here also of a binding enforcement mechanism will encourage individual countries to decide on their given production levels based on domestic, rather than global, calculi.
Indeed, “wait and see,” seems to be the most prudent counsel at present.